Thursday, January 31, 2013

Definition of Money

There are two common ways to characterize money. The first is the idea that money is a commodity like gold, silver or apples. And like any commodity when the supply increases the value or price declines. The second theory of money stated in my book, Rule of Money, defines money as a coupon equivalent to the work effort expended. Money, in whatever form, equals the work done to earn it.  Money is the physical evidence of earnings obtained by working for someone. It is a chit that can be exchanged for products equal to the value of the service provided to earn it. This right of exchange is guaranteed by law in most countries.

I define the Rule of Money as it must be earned to distinguish it from money created by the Central Banks of the world. I draw this distinction and show in my book that funds that Central Banks create do nothing to increase the wealth of a country unless the money is earned. If this was not the case countries with hyperinflation rates approaching 1,000,000% like Zimbabwe or Hungry and Greece after WWII would be the envy of the world with their currencies denominated in billions and trillions. When currency is stated in a billion or trillion Zimbabwe dollars or Hungarian pengo it is no longer connected to the value of work. It is only a point on an inflationary spiral. At this point money is no longer connected to reality. Money must be grounded in the value of work otherwise it is a meaningless value.

Money is not a new invention. It began as a way for Kings, Pharaohs, Sultans and similar political leaders to increase their wealth. They could make money for less than the value they stamped on the coin. The more they produced the richer they became. Most early inflation occurred when these Princes decided to reduce the thickness of a coin or insert lower valuable minerals during casting, but left the value stamped on the back unchanged. Their attempt to gain some unearned income usually failed. Most of the time this attempt to maintain the value of their coinage while reducing the precious metals inside was rejected by users of the coins resulting in currency inflation. The value of coinage dropped, but still reflected  the market value of the precious metals contained within the coins. If a monarch reduced the silver content by half, the value of the coin lost half its value.

When money is defined as a commodity it is subject to supply and demand pricing. Supply and demand pricing of money allows Central Banks to push the value of money up and down by adjusting interest rates for people or banks that have money. For people and companies that need to borrow money it makes their life more difficult and more expensive. Conversely, when money is defined as a receipt for work it is not affected by changes in interest rates.

Similarly, when money is defined as a commodity it is subject to inflation. The value of money fluctuates up and down with the commodity the currency contains or is redeemable for. On the other hand when money is defined as a receipt for work it is not affected by changes in commodity prices. It is affected by changes in labor rates. This is why in the 2000s inflation was low in western countries and high in Asian countries as labor rates adjusted.

One of the prevailing theories in modern Economics is the assumption that simply increasing the quantity of money in circulation causes inflation. When money is defined as a receipt for work it is not affected by changes in the quantity of money in circulation, because there is a one to one relationship to increasing earning and an increasing quantity of money.  On the other hand, when money is defined as a commodity the quantity of money in circulation is paramount, because an increase in a commodity reduces the overall value of the commodity in circulation. It is the level of supply that determines value. In conventional Economics, if a government increases the quantity of money in circulation the theory states the value of money will fall, because the demand for money is less relative to the supply. Whereas, N Theory states the quantity of money does not matter as long as the money is earned through work. But “unearned” money added to the money supply causes the value of all money to fall. One of the most prevalent kinds of unearned money is sovereign debt. Sovereign debt is unique among all other debt. It is not an investment, but only a promise to repay. It is not backed by an asset or redeemable by acquisition of collateral.
When a Central Bank like the Federal Reserve Bank in the U.S. decides to increase the amount of money in circulation they do so to stimulate business activity, thereby creating more jobs. But by modeling money as a commodity the Fed is constrained by their fear that increasing the amount of money in circulation will cause inflation. On the other hand, if the Fed understood money as only earned revenue according to the rules of N Theory they would not fear inflation. They would expand monetary assets by encouraging new business creation.
The way the Fed defines money affects how they manage the monetary resources of the country. The definition of money affects government policy. When money is considered a commodity the government is in charge of opening and closing the money spigot. Unfortunately, this opening and closing is governed more by a fear of inflation than by the factors of employment or business creation. On the other hand, when money expansion occurs according to N Theory employment is step one. Consequently, the justification for monetary expansion precedes the increase in the money supply effectively preventing currency inflation since there is no excess.

How should money be defined? Money is any object or equivalent electronic notation recorded to an account in a financial institution that is earned through work, and that can be exchanged for different products or services.

Tuesday, January 29, 2013


Adam Smith defined Economics as the process of wealth creation, but by the early 20th century the economists of the time stated a different purpose for Economics. Economics became the process of redistributing wealth. Redistribution is one of the cornerstones of Keynesian economic policy. The idea begins with the assumption that money is unfairly distributed. This is based on the observation that the amount of money possessed by some people does not seem to be based on fairness. This was definitely the case when Kings and Sultans possessed most of the wealth in their countries. This unequal distribution resulted from their control over the manufacturing of money. For hundreds of years money was simply a product of the monarchy. The common man earned money by doing things for the monarch. This traditional way of distributing money is still advocated by many economists as a solution to the disruptions of money flows during a financial crisis. Their logic is that the state creates the money, let the state decide who gets a share. These economists believe the state is much wiser at determining who gets what than the market system. Or that the market system is imperfect and can be improved by strategic monetary infusions by the state. This modified monetary structure is justified, because it is the right thing to do. The poor need care. The weaker members of the flock need shelter and food, and only the state can do so with the proper level of concern.
The origins of these traditions trace back to the concept of compassion. Compassion is a key virtue promoted by all major religions in the world. It is a quality that all religious people should seek to integrate into their actions. Therefore, the fact compassion permeates our economic traditions is no surprise. Likewise, it is no surprise that the competing secular philosophy of the market system is characterized as evil or godless. Such criticism is simply a protective religious response to a system that does not on first glance appear to have compassion at its heart.
Money must be distributed throughout a community for there to be a vigorous and robust economy. If money is left in the local bank or buried in the backyard, most people will not earn enough money to feed their family or pay their bills. Money needs to circulate and expand. Circulation or distribution can occur in two ways. A strong political leader can control all money through taxation or by managing the printing presses. Then it is a simple matter of determining who gets what. Most monarchies tried this method with greater or lesser degrees of success through the 19th century. Louis XIV used the construction of Versailles to distribute money in his society through the craftspeople and suppliers working on the project. Napoleon used his soldiers to spend money into the French economy. In other countries he used his soldiers to rob or plunder for survival. In the twentieth century Central Banks allowed private banks to make loans to emerging businesses to encourage economic expansion of the economy. The amount of wealth created in the twentieth century is greater than all the previous centuries combined. Clearly, no other system worked as well as the system employed in the 20th century when it came to the amount of wealth created. So what does history teach us? Based on the results obtained in the twentieth century versus the wealth creation in all previous centuries, it is clear the market system creates more wealth and quicker than any other system of wealth accumulation.
Redistribution is not a system of wealth accumulation. It is really a system of reengineering the last stage of the wealth accumulation process to redirect the final destination of the money accumulated. Redistribution ends up being a mirage even for those people who benefit from the redistribution. Why, because the government’s tax piece will be quickly replaced by higher prices and greater profits by the people who run businesses. This is why it costs more to live in New York or San Francisco (two of the most highly taxed communities in the country).
So, if I have convinced you redistribution is not a wealth accumulation process than what is the wealth accumulation process for the followers of the redistribution mantra? The wealth creation process for the business sector is capitalism. The wealth accumulation process for the government sector is the taxation process. One can argue that this is not really a wealth accumulation process since all the money is created by the market economy of the private sector.
The conclusion economists must draw from this process is that redistribution is not an effective wealth creation process. Redistribution just moves money from one side of the table to the other. It is a redistribution process like poker is a redistribution process without the fun. Just like a casino, government takes a fee for setting up the game.
Redistribution is not an economic concept. Redistribution is a justice concept. It is based on fairness and judgments about what is "right." This type of legal right does not belong in an economic discussion, because economics is not morally based. Redistribution is used as a justification for government to intervene in the market economy and correct the errors. This makes redistribution a government technique, not an economic principle. Redistribution may be the right thing to do, but that is only because the citizenry agreed it was.

To return to Adam Smith, redistribution is not a wealth creation process so it does not fit the definition of an economic process. Redistribution is a social process. As such redistribution should not be a consideration during optimization of the economic system. Many economists claim Economics is about a "fair" distribution of income, but it is not. Economics is about creating wealth.

Sunday, January 20, 2013


Economics does not seem like the kind of thing that was invented by one person. It seems like it probably came together slowly as customs became established and slowly turned into rules.  Today it is an immensely elaborate and complex system. Many of the most interesting features are relatively modern. Transportation certainly began with a man or a woman simply walking between tribal settlements, but now involves planes, trains and ships of immense size and complexity. Although it began hundreds of years ago, the whole banking structure of trade in just the past one hundred years has evolved into numerous complex currency and interest rate swaps and loans of millions of dollars. Corporations begun in Roman times to share the rewards of collecting taxes are now multi-national organizations with factories across the world producing everything from Barbie dolls to industrial acids that can cut through metal. The intricate metallic machinery and robots involved in the manufacturing process seem to be the inventions of Hollywood.

Are we on the right path? Do you think this was the direction of the tribal councils of Africa who began this process? What were they trying to achieve? It seems like the motive would be quite basic.  One tribe has a surplus of fish, but would like to get more berries from their neighbor who has a large berry patch on their tribal grounds. It is easy to visualize this process evolving into a structure needing a system of weights and measures and then money, next more advanced techniques for growing crops, then improvements in tools, organizations to produce manufactured products and along the way a system to make more money. Bottom line, it does seem reasonable to assume our economic system evolved as a trading mechanism.

The reason I asked this question is the simple feature of our humanness that makes us more efficient and focused when we know what direction to go in to reach our goals.  No economics book I know about declares the foundation of economics is trade. In fact, almost all economics’ textbooks start by explaining economics is about allocating scarce resources, i.e., deciding who gets a fish and how often. I must disagree with the esteemed academic community. I think this process of deciding how the tribal bounty is divided is a political decision.

The fisherman who caught the fish certainly feels the fish belong to him and that he will decide who gets what.  It requires some political might to wrestle control of the fish away from the fisherman.  I cannot imagine a fisherman in a primitive society giving up his fish to the tribal leadership to be redistributed without some political force in play. It is also not as clear how that process leads to the creation of money or huge trading vessels. Therefore, I believe scarcity leads not to the creation of Economics, but to the creation of Politics.

Economics does not originate with scarcity, but the need to have an efficient and effective trading system.